Improving Corporate Insolvency Law

This assignment delves into a proposed reform of Australian corporate insolvency law. The analysis examines the spirit of the proposal while highlighting potential implementation challenges. It recommends a carve-out approach over a defense mechanism and suggests refining the 'better outcome test' criteria to reduce uncertainty. The analysis emphasizes the importance of viability over insolvency as the foundation for the provision.

An Analysis of Recent Safe Harbour Proposals 1
AN ANALYSIS OF RECENT SAFE HARBOUR PROPOSALS VERSUS CURRENT
LEGISLATION ON INSOLVENT TRADING IN AUSTRALIA
by [Author(s) name(s)]:
Word Count: 2016
TABL5541: Corporations & Business Associations Law
(Tutor)
University of New South Wales
(City and State)
(Date)

An Analysis of Recent Safe Harbour Proposals 2
Table of Contents
Introduction................................................................................................................................3
An Examination of the Differing Elements...............................................................................3
Issues......................................................................................................................................3
Rules and Application............................................................................................................4
Conclusion..............................................................................................................................6
An Analysis of the Effectiveness of the Safe Harbour Proposals in the Exposure Draft..........6
Conclusions................................................................................................................................8
Recommendations......................................................................................................................9
References................................................................................................................................10

An Analysis of Recent Safe Harbour Proposals 3
An Analysis of Recent Safe Harbour Proposals versus Current Legislation on Insolvent
Trading in Australia
Introduction
The Australian position on insolvent trading imposes harsh liability on directors who engage
the company in trade or incur further debts when it is insolvent or they have reason to believe
it would be insolvent (Dorey & Rees, 2016). The challenge lies however in determining the
point at which the Company becomes insolvent; this uncertainty creates a challenge for
directors with regard to undertaking the option of restructuring the company in order to
mitigate the evident risk. Recently, the Ministry of Revenue and Financial Services tabled a
draft legislation that purposes to reform the current regime on insolvency trading by creating
a ‘safe harbour’ provision in the Corporations Act 2001 (Cth) that would protect directors
from personal liability in cases of insolvent trading and allow them the opportunity to
undertake restructuring so as to ensure the company’s recovery in case of hardship (The
Treasury, 2017). The following discourse aims to analyse the differences between the
proposed amendments and current legislation on insolvency trading. Further, the study will
engage in an analysis of the effectiveness of the proposed amendments, drawing conclusions
and making the relevant recommendations to this regard.
An Examination of the Differing Elements
Issues
In order to effectively analyse the differing features of the current legislation and the
proposed amendments, it is first and foremost important to highlight the essential features of
both provisions. In that regard the following segment will consider the following:
1. Who owes the duty?
2. When is the debt incurred?
3. When is the Company Insolvent?

An Analysis of Recent Safe Harbour Proposals 4
4. What are the available defences?
5. What are the consequences imposed in case of liability?
Rules and Application
The current position reflected in the Corporations Act 2001 (Cth) under section 588G
imposed a duty on the company director to prevent insolvent trading by the company. The
purpose of this statutory provision, which would find a director personally liable for incurring
debt when a company is insolvent, is to discourage commercial dishonesty or irresponsibility
on the part of directors. This was the position held in Edwards v Australian Securities and
Investments Commission [2009] NSWCA 424. The duty is therefore owed by a company
director; inclusive of shadow and de facto directors, holding the position at the time the
company incurs the debt. The proposed amendments uphold the duty owed by directors to the
company and other stakeholders to prevent insolvent trading, the provisions of s 588G are
unaffected by the Exposure Draft, however, the harshness of the liability imposed on
directors is mitigated as shall be seen in the subsequent discussions.
As aforementioned, current legislation presents some uncertainties with regard to the
determination of when the company is insolvent. Section 95A of the Act 2001 describes
insolvency as the inability to cover debts if and when they become due. As such, should a
director cause a company to incur debt at such a time then they would be in breach of their
duties under s 588G. Powell v Fryer [2001] SASC 59 outlines an objective test that courts
have relied on to determine insolvency (Redmond, 2013). According to the holding, in this
case, insolvency is determined after having considered the organization’s financial position in
its entirety. The introduction of recent amendments mitigates the liability arising from the
position set by the provisions highlighted above. Section 588GA proposed under the
Exposure Draft provides a safe harbour for directors from the liability imposed by the s 588G
penalty. Currently, failure to prevent insolvent trading leads to an automatic contravention of

An Analysis of Recent Safe Harbour Proposals 5
the duty imposed above. However, with the safe harbour provision, directors who undertake
measures to restructure and attempt to create a better outcome for the company are excluded
from the liability imposed by current legislation.
Another difference in the two instruments with regard to insolvent trading presents itself in
the defences available to directors. Currently, s 588H of the Act 2001 avails a director
various defences to avoid personal liability. These defences include reasonable expectation of
solvency on the part of the director, reliance on reasonable information from a competent
person as regards the solvency of the company, absence from a managerial position due to
illness of any other plausible reason at the time of insolvency and finally that reasonable
measures were taken to prevent the incurrence of debt (Lewis, 2010). Reasonable steps
provided under s 588H (5) can be construed to provide a safe harbour where directors could
opt for voluntary administration as illustrated in Statewide Tobacco Services Ltd v Morley
(1990) 8 ACLC 827. The Exposure Draft, however, considers these defences as ‘other
defences’ and expressly provides a safe harbour provision for directors. The provision acts as
a primary defence for a director who undertakes a reasonable course of action to create a
better outcome for the organization and its creditors where they suspect a likelihood of
insolvency. This defence, however, is limited to debts incurred when a director commences a
course of action up to and when the action is completed or found to be unenforceable
(Deloitte, 2017).
Further, as previously mentioned, the test for solvency is determined by an examination of
the organisation’s financial status. The financial position of any organisation is evinced in its
books or financial statements. According to the Exposure Draft, and organisation’s books can
be relied on to support the defence for safe harbour, however, this provision is limited in as
far as the director fails to permit or present the books for inspection or where they are found
to have concealed or destroyed some information. As such, where directors fail to deliver

An Analysis of Recent Safe Harbour Proposals 6
books for inspection they cannot rely on them as evidence to support the safe harbour defence
(Arnold Bloch Leibler, 2017). However, an exception lies where the director can prove they
lacked possession of the books in question and made all reasonable efforts to obtain them to
no avail. The current legislation lacks this provision with regard to the reliance of books as
evidence for a defence; it is limited to the safe harbour provision which is novel to Australian
Corporations Law.
Conclusion
Evidently, as discussed above, the differences between the two provisions lie in the weight of
liability accorded to directors in their duty to prevent insolvent trading. The duty is still owed
by directors but the defences available are expanded to avail a safe harbour which cures the
uncertainty created by the determination of a company’s insolvency. The consequences for
breach, however, remain the same in that both civil and criminal penalties are accorded where
liability is ascertained.
An Analysis of the Effectiveness of the Safe Harbour Proposals in the Exposure Draft
The proposal was met with a majority of positive feedback by way of submissions and
deliberations on the parliamentary floor. Scholars and Institutions expressed support, albeit
with recommendations, as to the proposed amendments. Geoff Green, in his submissions as a
Chartered Accountant and formerly registered liquidator found the framework set out in the
draft with regard to the safe harbour provisions as strong and sensible (Green, 2010).
Anderson et al. also cite support for the provision expressing that the evidentiary burden in
conjunction with the criteria relied on by court to determine the legitimacy of the course of
action limits the scope in which one can engage in illegal phoenix activity in the guise of
restructuring as such creating an environment that enables business rescues while limiting the
scope for abuse through fraudulent actions. Despite the strong show of support, the provision
has been challenged with regard to effectiveness on the following issues.

An Analysis of Recent Safe Harbour Proposals 7
The Harmer Report (1998), outlines various principles and objectives to be considered in the
development of Insolvency Law in Australia. As such, legal provisions and amendments
should embody these objectives. Among these guidelines is the principle that any law
regarding insolvency should support the commercial and economic processes of the
community. As such, the law should ensure it creates an environment that allows for the most
suitable solution that would least disrupt the commercial and economic processes in question.
Tested against this principle the safe harbour provision can be described as effective as it
cultivates an environment that would allow for the continuity of the business by availing an
opportunity for recovery through restructuring which if successful ensures commercial and
economic processes are maintained and even improved.
The Australian Institute of Company Directors (AICD), submitted additional criticism to the
proposed safe harbour provision citing uncertainty and complexity as the contributory factors.
According to the Institute, the provision for ‘better outcome’ as expressed under s 588GA
sets a prerequisite on directors to evaluate possible outcomes to their decided course of action
in comparison to the outcomes available in becoming a Chapter 5 body corporate in order to
rely on the proposed defence. The AICD finds the requirement formidable as it is uncertain to
the extent that it relies on an analysis of predictions on potential future events. Further, it is
complex as the analysis is juxtaposition with a Chapter 5 Corporate body; as per the law there
are various ways for a company to become a Chapter 5 Corporate body and as such analysing
the possible outcomes from all these avenues would be unduly onerous (AICD, 2017).
Herbert Smith Freehills hold a similar opinion citing that the better outcome test sets the bar
too high as such creating an element of complexity and uncertainty (Apathy, et al., 2017).
Clayton Utz in their submissions outlined support for the proposal citing that it would be
effective in creating a safe harbour for company directors with regard to the personal liability
imposable for insolvent trading (Clayton Utz, 2017). Further, they recognised that the criteria

An Analysis of Recent Safe Harbour Proposals 8
adopted under s 588GA, which is subjective, is suitable and relevant to the better outcome
provision. However, according to Clayton Utz, this effectiveness is limited in as far as the
proposal is enforced as a carve-out rather than a defence. That is, in as far as the provision
serves as an exclusion from the provisions on civil insolvency trading, rather as a defence in
proceedings regarding breach of duty.
Further, according to Dong Lin, in order to be effective, the provision should expressly adopt
the concept of viability rather than solvency; that is the law should require that directors
efforts be made towards long-term viability over the solvency of the organisation (Lin, 2017).
Viability is a concept that considers the long-term success and survival of the company over
solvency which in essence is a short-term objective. Solvency should be achieved and
maintained; this is only possible if the course of action is driven by viability.
Conclusions
It is evident therefore from the discussion above that the provisions of the Exposure Draft
steer a cultural shift among directors as they would encourage greater involvement in
analysing and mitigating financial challenges. This is because it creates an environment in
which directors can explore restructuring options that are likely to lead to a better outcome
for the organisation and its creditors. This effectiveness, however, is limited to the extent that
it bears some uncertainties and complexities that inhibit its success. This is because the
criteria set to analyse the viability of the course of action are too high, further as they involve
an analysis of future predictions they are marred by uncertainty. However, it is evident that
the general concept behind the provision is effective; the challenge arises in its enforceability.
As such, it can be concluded that the provisions of the Exposure Draft are effective subject to
further amendments.

An Analysis of Recent Safe Harbour Proposals 9
Recommendations
In consideration of the discourse thus far, the study recommends that further amendments be
made to the current proposal. The spirit of the proposal is rational; however, as outlined
above, certain challenges are likely to arise in the course of implementation. The research,
therefore, recommends as follows:
 Clarity is effected as to whether the provision is acting as a carve-out or a defence; the
study recommends a carve-out approach.
 The criteria as to better outcome test are evaluated to mitigate rising uncertainties as
discussed.
 The provision is based on the concept of viability over insolvency.

An Analysis of Recent Safe Harbour Proposals 10
References
AICD, 2017. National Innovation and Science Agenda- Improving Corporate Insolvency
Law: Submissions, s.l.: The Treasury.
Apathy, P., Spencer, S. & Flippin, L., 2017. Australian Government Releases Draft Insolvent
Trading and Ipso Facto Legislation. [Online]
Available at: https://www.herbertsmithfreehills.com/latest-thinking/australian-government-
releases-draft-insolvent-trading-and-ipso-facto-legislation
[Accessed 19 September 2017].
Arnold Bloch Leibler, 2017. Improving Corporate Insolvency Laws Submission, Melbourne:
Arnold Bloch Leibler.
Australian Law Reform Commission , 1998. Australian Law Reform Commission General
Insolvency Inquiry (Harmer Report), s.l.: ALRC.
Clayton Utz, 2017. Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 -
Submission to Treasury from Clayton Utz , Sydney: Clayton Utz.
Deloitte, 2017. Deloitte Submissions: Safe Harbour. s.l.:Deloitte.
Dorey, I. & Rees, E., 2016. The Harbour is Not Yet Safe-Reform on the Move in Australia,
s.l.: K&L Gates.
Edwards’s v Australian Securities and Investments Commission (2009) NSWCA 424.
Green, G., 2010. Submission on Exposure Draft, s.l.: The Treasury.
Lewis, P. L., 2010. Insolvent trading defences after Hall v Poolman. Company and Securities
Law Journal, Volume 28, pp. 396-410.
Lin, D., 2017. Submission Regarding Insolvency Law Change, s.l.: University of New South
Wales.
Powell v Fryer (2001) SASC 59.
Redmond, P., 2013. Corporations and Financial Markets Law. 6th ed. s.l.:LBC.

An Analysis of Recent Safe Harbour Proposals 11
Statewide Tobacco Services Ltd v Morley (Morley's Case) (1990) 8 ACLC 827.
The Parliament of the Commonwealth of Australia, 2017. Exposure Draft: Treasury Laws
Amendment (2017 Enterprise Incentives No. 2) Bill 2017, s.l.: Treasury.
The Treasury, 2017. National Innovation and Science Agenda – Improving corporate
insolvency law. [Online]
Available at: https://treasury.gov.au/consultation/national-innovation-and-science-agenda-
improving-corporate-insolvency-law/
[Accessed 20 September 2017].